UPDATE 1-PIMCO's Gross warns of lower returns on corporate bonds

Wed Feb 27, 2013 9:53am EST

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By Sam Forgione

NEW YORK Feb 27 (Reuters) - Bill Gross, founder and co-chief investment officer of bond giant PIMCO, told investors in a monthly letter on Wednesday they should expect lower returns from high-yield corporate bonds.

Gross, whose Pacific Investment Management Co runs the world's largest bond fund, said that corporate credit and high-yield bonds are "somewhat exuberantly and irrationally priced" and are being propped up in part by the Federal Reserve's ongoing bond-buying program that has kept interest rates low.

"On a scale of 1-10 measuring asset price 'irrationality,' we are probably at a 6 and moving in an upward direction," Gross wrote in the letter.

Gross said that high-yield bonds with current interest rates of 5 to 6 percent are likely to produce a real return of just 3 to 4 percent after taking into account future defaults and recovery rates.

He added that while investors should be cautious of lower returns in the high-yield bond market, they should not abandon them completely.

Gross added that the Federal Reserve's bond-buying, known as quantitative easing, has "unduly influenced" returns from both high-yield bonds and stocks.

"If and when the support dissipates or if the economy remains anemic, investors should be cautious and temper their enthusiasm," Gross said.

In past investment letters, Gross has warned investors of looming inflation as a result of the Fed's monthly purchases of $85 billion in agency mortgage securities and Treasuries. He has said that such inflation will weaken returns on bonds and stocks, and also hurt business models.

The Newport Beach, California-based PIMCO oversaw $2 trillion in assets as of December 31, 2012, according to the firm's website. The PIMCO Total Return Fund, the world's largest bond fund with $285.6 billion in assets, has earned a return of 0.17 percent so far this year, the website showed. (Reporting by Sam Forgione; Editing by Chizu Nomiyama)

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